Family Finance: How not to use a line of credit

In Quebec, a couple we’ll call Yvette, 47, and Georges, 51, are living comfortably in a charming house more than a century old bordering a lovely lake. When he is not working as a manager in his employer’s manufacturing business, Georges works on the house, skis cross country and teaches martial arts. Yvette teaches in a private school. She is a devoted gardener. It seems a picture-perfect life, but the couple are not able to get by on their combined $7,459-a-month take-home pay, for their debts are piling up. Their retirement will be devastated if they cannot get those debts and perhaps others in future under control.

Yvette and Georges owe $180,000 on a home-equity line of credit and $25,000 on a car loan. The interest charges, $500 a month for the house and $560 for the car loan, total $1,060, are a manageable sum. But management is the issue, for the couple does not track spending or income. Rather, they have their paycheques deposited directly to their line-of-credit account, then draw on the account for expenses. The net difference per month ought to show whether they are reducing debt or accumulating it. They are letting their lender run their piggybank while charging interest on deficits.

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At some time in the next decade or two, Yvette will inherit two properties from her mother, now 75 — a principal residence worth perhaps $350,000 and a cottage worth about $200,000. She is paying her mom $1,125 a month to buy the house. It is a generous way of giving her mom additional cash flow.

Family Finance asked Caroline Nalbantoglu, a financial planner at PWL Advisors Inc. in Montreal, to work with Yvette and Georges. The problem with the arrangement that the family has made is in valuation of the properties and potential tax obligations.

Properties and taxes

When Yvette’s mother dies, which may be many years hence, capital gains on her house, a principal residence, will not be taxed. But the cottage has appreciated perhaps $200,000 over the past few decades. If the cottage is not sold before her mother’s passing, it could wind up in Yvette’s hands and attract a substantial capital gains tax, Ms. Nalbantoglu says.

It would be helpful to plan to cut down on the couple’s properties. If they do not, they would in theory wind up with three parcels of real estate, each subject to rising interest rates on their mortgages and line of credit. All that would be in addition to the car loan. The properties might need repairs and they would be subject to property taxes. Best plan: Sell the cottage, pay perhaps $50,000 capital gains tax. What’s left, $150,000, would support Mom for a decade on top of her Old Age Security and Quebec Pension Plan benefits, the planner says. If Yvette then uses the $1,125 she pays her mother each month with another $500 out of pocket, she can clear her own line of credit in 15½ years. The couple should set up tax-free savings accounts as well.

Retirement plans

Georges has two sons for whom he pays $1,000 a month via a separation agreement with a former spouse. The money is deducted from his pay and is not part of cash flow in his present marriage. He will pay for them for another four years. Then the deductions will stop and his pay will rise by $1,000 a month.
At age 60, Georges will be eligible for a pension of $69,700 a year in future dollars. It is indexed and integrated with the Quebec Pension Plan, so it would drop by $14,670 at his age 65, when QPP begins. He can take QPP as early as 60, when he could receive a reduced benefit of $8,811 in future dollars. Georges’s total income at age 60 would then be $78,510 a year. His income at age 65 from various company and private pensions, QPP and OAS would be $87,960, the planner estimates.

At age 65, Yvette should have $486,000 in her defined-contribution company pension plan. Her RRSPs will have grown to $338,000. Added up, she will have $824,000 in total registered assets. If she turns the accounts into RRIFs and withdraws minimum amounts, she will have investment income of $32,960 a year. She will receive Old Age Security and Quebec Pension Plan benefits that total $25,400 in future dollars. Together with Georges’s age 65 income from all sources, they will have $171,757 in future dollars. Assuming they split pension income and pay only $2,729 each in OAS clawback penalties when the clawback has risen from $67,668 at present to perhaps $78,500 in the next decade and a half, they would have $108,100 to spend each year, or $9,000 a month. If debt charges are eliminated, their monthly expenses in retirement would be $5,746, which leaves them a substantial cushion for unforeseen house repair costs or other expenses, Ms. Nalbantoglu notes.

It is important for Yvette’s mother to execute a power of attorney, known as a mandate in Quebec, giving her daughter the ability to manage her assets in the event of an incapacity. Mom’s will should also be reviewed, as should the wills and powers of attorney of Yvette and Georges. It is vital to have valid powers of attorney in place, for without them, in the event of stroke or other incapacitating event, a public trustee – in Quebec, the Public Curator – would step in. That is not a desirable outcome, Ms. Nalbantoglu warns.

“The couple can have a comfortable retirement even if they don’t increase their savings, thanks to Georges’ indexed pension. But the key is that they get to retirement without debt. That requires selling the cottage before long and, as well, moving to a simple budget in which they track income and expenses individually.”

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Need help getting out of a financial fix? Email andrewallentuck@mts.net for a free Family Finance analysis.

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By clicking "Create Account", I hearby grant permission to Postmedia to use my account information to create my account.

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